The myth of private REITs

The “private” REIT – proposed as an appropriate structure for a real estate joint venture or closely held fund – is increasingly shrouded in a cloak of mystery. In reality, this is not a new vehicle at all but simply a company that elects for REIT status and carefully manages the conditions of the regime that require wide ownership, writes Nicola Westbrooke, real estate tax partner, EY. Below are the benefits a “private” REIT can provide and what issues might arise in putting one in place. Fortunately, the issues involved are normally manageable and no magic is necessary. SEE ALSO: EY’s new real estate tax trio: open for business Changes to legislation The REIT regime became much more attractive in 2012, when HMRC made significant changes to the legislation, abolishing the entry charge and introducing the concept of the “institutional investor”, which meant that large stakes could be held by qualifying investors – sovereign exempts, insurance companies, pension funds, other REITs, housing associations and others. For joint ventures with investors that fitted this criteria, “private” REITs became possible, although the REIT parent company still needs to be listed from the start. The various London exchanges and Channel Island exchange are popular. To qualify as a REIT, a number of conditions need to be met, although some don’t need to be met for a period after the vehicle has launched. Absent of any other issues created by the business model of a particular REIT, the art of structuring a “private” REIT is to focus on those conditions which are harder to meet with a small number of investors: ■ The REIT company (or parent company if it is a group) must not be “closely held” by the time of its third anniversary. The test is fiddly but will certainly be met if the company is controlled by one or more “institutional shareholders”. Sometimes the answer is self-evident and sometimes status (such as sovereign immune status) needs to be checked with HMRC. ■ The shares of the REIT parent company must be “admitted to trading on a recognised stock exchange” so a suitable one needs to be chosen. What is important to the investors? Costs of listing and operation? Reputational issues? Liquidity? Flexibility of the exchange in discussions of how their diversity of ownership tests can be met? In addition, if HMRC accepts that an exchange is “recognised” but inclusion of a share on that market does not count as being “listed” then the shares of the REIT must meet a fairly lightweight “trading” condition at some point before the end of the third year of operation and thereafter. For example, AIM and the NEX Exchange in London require a trading condition to be met but listing on the Channel Islands Stock Exchange does not. ■ The REIT will suffer a penalty if it pays a dividend out of the exempt part of its business to any corporate shareholder owning 10% of more of its shares. This means an analysis must be done on whether any of the large shareholders are bodies corporate. If so, the normal way to deal with this is to hold REIT shares via a number of subsidiary companies which all own less than 10%. HMRC is happy with this structuring but it causes a problem whereby the subsidiaries would then not themselves be “institutional investors” for the purpose of the “close” test outlined above (for example, subsidiaries of an insurance company or sovereign exempt body). In these circumstances, HMRC has been happy in the past with the use of a limited partnership below the “fragmentation” subsidiaries so that the partnership meets the institutional investor test. A “private” REIT is by no means the only answer to structuring joint venture investment into UK property – a plethora of other options exist – but it can be a good fit. The good news is that the technology to make it happen is now tried and tested so if it looks like a winning solution for your circumstances, it does not take rocket science to make it work. Main image: © PhotoAlto/REX/Shutterstock